Other cultures, other accountings

A modern literature of Islamic accounting

Most countries with a majority Muslim population were either occupied as colonies of Western countries or were strongly under Western influence until after the Second World War. To Muslims around the world, this led to a dilemma: should Islam change to accommodate the scientific, technological, political, social and economic advances associated with the West, or should it attempt to recover some “Golden Age” of Islam, if necessary through separating the Muslim community from the cultures within which it was located? Reformers discussed notions such as the Islamic state and the Islamic economy, and the roots of modern Islamic accounting may be found in the social and economic discourse, and attempts to put this into practice, that they stimulated.

In the post-colonial period, although countries that had never been colonised regarded the relationship between religion and society in quite different ways, they tended to follow Western accounting practices. In the 19th century, the Ottoman Empire had taken its Commercial Code from France and had later been influenced by German accounting practices (Toraman et al., 2006a). Its 20th century successor Turkey, which had adopted deliberately secular policies, looked to the West for its accounting practices (Orten, 2006; Orten & Bayirli, 2007). At the other extreme, Saudi Arabia, where the austere Wahhabi interpretation of Islam has dominated society, has also tended to take its accounting practices from the West (Naser & Nuseibeh, 2003). Some countries, such as Pakistan and Iran, have consciously identified themselves as “Islamic” republics and have aimed to adopt Islamic laws – the Shari‘ah – for all aspects of human life including economic interaction. In addition to the intellectual justification provided by the different forms of “Islamism” emerging in the post-war period, the significant and persisting wealth transfers to the Middle East following the oil price rises of the early 1970s furnished economic underpinning for the creation of Islamic financial institutions.

The emergence of a scholarly literature of Islamic accounting in the English language can be dated fairly precisely to 1981, in which year Abdel-Magid proposed a tentative theory for the accounting practices of Islamic banks, which were beginning to emerge at that time as a significant force. The author begins with a discussion of the Islamic Shari‘ah system (the principles and rules derived from the Qur’an and the Sunnah). He then explains how the Shari‘ah principles are applied through a range of Shari‘ah-compliant banking transactions, and concludes by asserting the need for specific accounting treatments for these transactions. Overall, there is a sense that Islamic accounting needs to be different from Western accounting:

[T]he environment of corporate reporting in Islamic countries will be characterised by political, social and economic forces different from the forces found in the Western business environment. Since political and economic forces are constraints on the objectives of corporate reporting and accounting standards, the emergence of an Islamic model of accounting is a real possibility. (Abdel-Magid, 1981, p. 97)

Since this paper, the Islamic accounting literature has tended to fall into three main groups. First, there are general discussions of the need for Islamic accounting, and what the broad principles of an Islamic accounting system might be. Some researchers provide a broad sweep of coverage and others focus more on specific aspects, such as particular accounting concepts. Most of the literature is prescriptive or descriptive. The literature in English includes Hamid et al., 1993; Adnan & Gaffikin, 1997; Baydoun & Willett, 1997, 2000; Mirza & Baydoun, 2000; Sulaiman, 2000; Lewis, 2001; and Haniffa & Hudaib, 2002. Notable Arabic language contributions include Al-Qabani, 1983; Shihadah, 1987; Attiah, 1989; and Zaid, 1995. Some studies also attempt to explain the choice of accounting practices by Islamic financial institutions. An example of this is the study by Maali et al. (2006) of social reporting by Islamic banks. This paper develops a prescriptive benchmark for high quality social disclosures that would be consistent with the Islamic basis of these banks, gathers data on actual social disclosures, and attempts some basic explanation of the data.⁵

The second main group considers accounting for Islamic financial products. Papers range from general conceptual reviews, discussing whether Islamic financial products are substantively different from Western banking transactions to justify different accounting treatments (for example, Al-Obji, 1989; Heakal, 1989; Archer & Karim, 2001), to examinations of specific transactions or issues. Examples of the latter class include the study by Al-Jalf (1996) of the accounting issues raised by the murabahah transaction (where a bank purchases items on behalf of a customer who takes immediate delivery but who reimburses the bank through future payments greater than the amount that the bank pays to the items’ supplier), the examinations by Al-Obji (1996) and Hmoud (1996) of how Islamic banks should measure and distribute profits from mudarabah contracts (where a bank’s customers invest in the bank through profit-sharing arrangements rather than interest-bearing deposits), and the review by Daoud (1996) of how Islamic banks ensure the religious propriety of their transactions through the use of Shari‘ah supervisory boards and advisers.

The third main strand of research into Islamic accounting looks at issues of regulation. Islamic financial institutions often argue that bank regulators and supervisors need “to fully comprehend Islamic banking and finance, to correctly identify and recognise the various credit, operational and market risks as well as other risks that are inherent in the Islamic banking business” (Aziz, 2007). Much of this literature discusses the Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI), established in 1991, which issues standards on accounting, auditing and governance for Islamic banks, insurance and investment companies. Several papers by Rifaat Ahmed Abdel Karim, for many years secretary-general of AAOIFI (Karim, 1990a, 1990b, 1995, 2001),⁶ discuss the need for specific standards, against a background of increasing international harmonisation of financial reporting, as well as addressing more general issues relating to the supervision of Islamic banks.

Karim provides an important personal link between research and practice. He took a master’s degree at the University of Birmingham under Trevor Gambling and later a PhD at the University of Bath under Cyril Tomkins (see Tomkins & Karim, 1987). Karim was greatly influenced by the emerging literature on social accounting, particularly Gambling’s Societal Accounting (1974), and he collaborated with Gambling on an early study of Islamic accounting (Gambling & Karim, 1986), and a more detailed book-length study of Islamic business ethics (Gambling & Karim, 1991). In these publications, Gambling & Karim emphasised the need for an Islamic accounting to be grounded in Shari‘ah, which implied a deductive approach to constructing an Islamic accounting theory. They identified and discussed factors affecting the Muslim community (the ummah), which they considered were likely to influence Muslim users’ needs relating to financial reporting. Two key factors are the prohibition of riba, sometimes interpreted as usury but more usually as all forms of interest (Mulhem, 2002),⁷ and the fundamental duty of all Muslims to pay the religious levy zakah.⁸ The prohibition of riba is the main driving force behind the growth of Islamic banking, using a range of contracts and transactions that are considered to be Shari‘ah-compliant to structure transactions that in traditional banking would involve some form of loan or interest-bearing instrument (El-Gamal, 2006; Ayub, 2007; Hassan & Lewis, 2007; Iqbal & Mirakhor, 2007).⁹

Gambling & Karim (1986) discussed the measurement principles underpinning zakah, which is a form of obligatory contribution to charity based on a Muslim’s wealth. Only particular types of wealth are subject to zakah, and wealth is measured using current values. Gambling & Karim (1991) argue that, historical costs would not provide information relevant to owners of businesses wanting to compute their liability for zakah, while assets should be classified in the balance sheet so as to identify what wealth is subject to zakah. Several other researchers have proposed zakah as a central motivation for Islamic accounting, and have tended to endorse the need for some form of current or exit valuation instead of historical cost. The studies by Hamid et al. (1993), Clarke et al. (1996) and Adnan & Gaffikin (1997) show the influence of Raymond Chambers’ continuously contemporary accounting (co-authors were students or colleagues of Chambers).

The modern Islamic accounting literature continues to thrive. The social focus of much of the more normative writing has begun to widen into environmental concerns (Kamla et al., 2006). More rigorous empirical studies are beginning to emerge. For example, Sulaiman (1998) tested the claim of Baydoun & Willett (1997) that current value balance sheets and value added statements would serve the needs of Muslims to a greater extent than historical cost balance sheets and income statements. She found no difference in the perception of the usefulness of both current value balance sheets and value added statements between Muslims and non-Muslims. Sulaiman (2001) further tested the Baydoun and Willett (1997) position using an experimental approach, and again found no evidence of a religion effect. Idris (1996) tested perceptions of preparers of financial statements in both Islamic banks and commercial banks that provide “Islamic windows” (separate departments offering transactions consistent with Islamic principles) regarding the items that should appear in the annual reports of Islamic banks. The respondents expressed the view that conventional statements like the balance sheet and income statements are the most important. Haniffa & Hudaib (2007), using a more extensive disclosure benchmark than Maali et al. (2006), examined how effective Islamic banks were in communicating their ethical identity as Islamic institutions through disclosures in their annual reports. Consistent with earlier research, they found a substantial gap between the ethical identities that Islamic banks were disclosing and what they considered to be the “ideal” ethical identities.

Maali (2005) combined research into contemporary accounting practices in Islamic institutions with a historical approach by investigating the impact of Islam on the accounting practices of Jordan Islamic Bank for the first 24 years of its operations. Maali found that, although the establishment of the Bank was clearly motivated by the desire to provide Shari‘ah-compliant banking in Jordan, tensions between religious considerations and the need to develop a commercially viable bank able to compete with more traditional operations in Jordan arose from the beginning. Over time, although the bank has continued to offer Islamic financial products to both depositors/investors and customers, and to ensure that transactions are undertaken under the supervision of experienced Islamic scholars and jurists, the need to maintain the bank’s competitive position has led to the use of Islamic forms of contract to create arrangements that echo more traditional Western banking transactions. Maali’s study provides an opportunity to study accounting change in an Islamic organisation over a period of time, which is one of the main objectives of historical accounting research (Napier, 2006). The next section of the paper considers other studies of Islamic accounting from a historical perspective.